Economics is one of those things that fundamentally influences our lives on a day-to-day basis. Yet most of us only somewhat understand what it is and how it works.
In the first part of this three-part series, we’ll take a look at classical economics — widely regarded as the first modern school of economic thought — and the historical conditions in which it arose. We’ll also discuss the work of classical economists and how they pioneered a new way of thinking about markets, the way market economics work, and the uniquely human tendency to produce, trade, and consume.
- [03:29] What is economics?
- [05:15] Historical context of classical economics
- [07:34] Mercantilism and how it works
- [11:58] The context in which Adam Smith wrote “The Wealth of Nations”
- [16:35] Adam Smith on the distribution of wealth
- [19:42] Adam Smith on the division of labor
- [23:52] Say’s Law and the theory of comparative advantage
- [27:38] The role of competition in regulating markets
- [29:28] Socioeconomic problems in the 19th century
- [32:17] The Iron Law of Wages
- [33:12] The government’s role in the economy, according to 18th- and 19th-century economists
- [38:28] Problems with the classical economic model
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[00:00:00] Intro: Forget the civilized path. It’s time to break the chains of debt and dependency, take control of our financial lives, and live free. This is the Fiscally Savage Podcast.
[00:00:16] Dylan Bain: Hello and welcome to Fiscally Savage. I’m your host, Dylan Bain. Happy Friday, everybody. If you’re new here on our Friday shows, we take something in the news and go one step deeper. But also occasionally, we go off in a series like I did back in December on FTX, the collapse, and cryptocurrency in general. And I’ve been looking at the news. I see a lot of repetitive stuff. And whenever that happens, Dylan gets bored, and when Dylan gets bored, Dylan tends to research a lot of different things. And then, we end up with a series because Dylan reads things so you don’t have to.
[00:00:47] And one of the things that I have been just fascinated in for the better part of 20 years at this point is the field of economics, and finance, and all the different ways in which we actually like move goods and services around the globe, playing this game with this imaginary thing we call money. And to that end, I’ve read just an inordinate amount of different books and articles, Wikipedia entries, and basically everywhere else that you can get research on the internet these days. But one of the things that it’s always fascinating to me is that when people will learn about a particular economic school of thought or a different philosophy, they tend to only like listen to the things that they themselves like. This, I think, goes with the age-old adage that human beings, at the end of the day, really just want to hear their opinion out of the mouth of somebody else. And economics is a great place for this because when you start talking about different economic theories, one of the things that has always fascinated me is how people leave out a huge chunk of whatever the economic theory was attempting to explain in favor of trying to push a particular ideological position or political point.
[00:01:56] And so what I thought I would do today is I would start a three-part series that are going to drop on these Fridays for the rest of the month, talking about the various schools of economic thought. Where do they come from? Who are the major players? What did they say? And how do they impact our lives today? Because economics is one of these things. It’s a lot like education. We all have experience with it. It fundamentally influences our life on a day-to-day basis. And at the end of the day, most of us only have a passable understanding of the actual mechanics of the thing itself. And so my goal here is to try to give you a foundation of something that you see all around you. Whether it’s in your job, or on the news, or when you go to the grocery store, the economy is kind of like the water that we swim in. And when we have things like the debt ceiling crisis, there’s always going to be the same prescriptions from the same different camps about to do this or to do that or this is causing inflation or that’s causing inflation. Everything from social welfare programs to monetary policy to what to do in the event of a recession or what the best ways to try to handle something like inflation is are coming out of these various economic schools of thought that have been picked up, or at least parts of them have been picked up, by various political factions within the United States government. And it’s, of course, not limited to the United States government. This is an everything phenomenon.
[00:03:29] So first and foremost, economics is a lot of things. But in short, it’s a social science that focuses on the production, distribution, and consumption of goods and services. That is to say that you could say that economics is trying to answer the question of how do we allocate scarce resources in the face of infinite human desires. Another way that you can put this is what should be produced for whom, by whom, and at what price. Economics, when you start to look at it in those terms, also forms kind of also another field, which is this study of incentives. How are humans responding to various economic signals, such as prices, within a market that is then driving their behaviors? And if we were an enterprising individual, how could we possibly tinker with those incentives to induce the behavior that we’re actually seeking?
[00:04:20] It’s also worth noting that there’s a lot of people who call economics the dismal science. The context around this is that because economics is trying to allocate scarce and finite resources, this leads to difficult trade-offs and tough policy decisions, specifically when it comes to things like the population, wages, profits, and all of those different types of things, specifically pessimistic predictions about how those trade-offs are going to drive resource allocation in the future. It typically goes pretty negative pretty quickly. And it’s worth noting that we as humans have been doing this for the entirety of human civilization. We’ve been taking scarce resources and trying to satisfy our desires. And, you know, I say civilized society, but chances are good we’ve been doing this for as long as we’ve had enough neurons to cobble together to create sentience.
[00:05:15] But for our purposes, we’re going to ignore most of that, and we’re going to start in the 16th century. And we’re going to discuss, first and foremost, what was going on when the study of classical economics as we understand it arose. So that is to say, what is the historical context that the people who first pioneered the idea of classical economics — although at that time, that’s not what they would have called it. It’s only in retrospect that we look at it and call it classical economics — what was going on, and what were they seeing? What was giving them the idea that they could catalog and understand what they’re actually looking at?
[00:05:55] So let’s start in the 16th century. Now, there’s a few things that you should really note about that date. The 16th century, which is the 1500s, is notable because this is the era in which the European powers were coalescing into what we call and understand now as nation states. So for example, like during this time, Spain was going through something called the Reconquista, where they were taking territory back from Moorish invaders that had ruled the Iberian Peninsula for centuries at that point. But Spain itself was a conglomeration of several small kingdoms that then were coalescing and unifying into an actual whole. And you can still see these division lines today. If you’ve ever heard of like the Basque region of Spain, that’s one of these culturally distinct groups inside of the nation of Spain. So they call it nation state because you have a nation, which is this overarching identity that everybody can kind of hook into, but it’s a conglomeration of individual little states. Every European power from France to England to what we eventually would call Germany was going through this process at this time. And basically, the other Eastern European countries were in various forms or another also doing this. But the fact that the Western side of the European peninsula had access to the Atlantic Oceans can be critical because the other thing that was happening during the 1500s was Spain was colonizing the living crap out of the New World.
[00:07:34] And so the economic system that Spain was following at the time was something that we eventually called mercantilism. Mercantilism is an economic system where the main function is to accumulate gold and silver. So if you are a collection of small states that are coalescing into a national whole, one of the things that you’re going to have to do is fight a ton of wars. And then, of course, if you’re looking over at your neighbor and going, “They seem to have this wild look in their eye,” you’re going to want to increase your military spending because you want to be the survivor state, but you want to be the result. Spain didn’t want to be part of France. And so they had to build up their army and their navy in order to be able to defend themselves. So the accumulation of gold and silver is critical to this process.
[00:08:26] There’s basically three ways that they could do this. They can either number one: dig up more in their country, which is kind of a crapshoot as to whether or not you actually have gold and silver around; number two, you could just be really good at selling something and have a positive trade imbalance. That is, you’re exporting more than you’re importing sort of the net flow of gold and silver is coming into the country. But by far, the easiest way to do this is to colonize someplace else and then strip them of their natural resources, which is more or less what Spain was doing. We, in fact, still have countries today that are named after what Spain found there. Argentina — well, you know, argent, that silver, that’s because that entire area was very rich in silver and they used the local populations and then later imported African slaves to mine out silver that they then brought back to the country, which then caused all sorts of bad economic results, such as rampant inflation. But I digress.
[00:09:19] And the issue now becomes is that if you’re England, you’re looking at this and going, “Well, I want to get my hands on that gold, but I don’t have a claim to, say, South America, so I’ll start colonizing into North America or maybe I’ll just let the Spanish do it all for me, and what I’ll do is I will issue something called a letter of marque in which I contract with a naval captain who happens to have a boat and cannons and say, ‘Hey, go raid the Spanish, give me half of everything you earn, and I will protect you with the power of the Crown.'” Which, of course, is exactly what was going on. The whole Age of Piracy arose because of England trying to dip into this colonialism to be able to get their own gold and silver. Literally all of the powers in Europe at the time, this was the goal: go colonize places, brutalize the population, strip out the natural resources, and bring as much gold and silver to you as you humanly possibly can.
[00:10:18] Now, this system creates protectionist and nationalistic foreign policies. That is to say that, remember — part of the way you run this game is you have a positive trade imbalance. So you want high tariffs and protectionist measures to keep your domestic industries very vibrant and very profitable by excluding other people from other markets. So then, of course, if you’re England and you want to sell stuff, where do you sell it to? Well, you go colonize a place like India and then sell them back a whole bunch of stuff. One of the things that we saw particularly during the subjugation of India is that India was really good for growing cotton. And so what Britain would do is they would grow the cotton in India, ship it back to Britain, turn it into textiles, and then send it back to India with having laws in which only English-produced cloth could be sold in the markets, and therefore were able to strip out gold and silver out of the Indian economy because those English merchants would then bring in their cloth, sell for gold and silver, and then take that back to England. This is just a way of stripping out the natural resources of a place. And it’s great if you are the one doing the taking. It’s absolutely terrible if you are literally anyone else. The problem here is this disincentivizes trade between nations, and it really is a zero-sum game. If you’re on the receiving end of a colonization, your life is terrible. They are going to destroy everything because the sole focus is on the accumulation of gold and silver. And they view it as a zero-sum game because it is.
[00:11:58] That, ladies and gentlemen, was the economy in which Adam Smith found himself in 1776 when he published a book called An Inquiry into the Nature and Causes of the Wealth of Nations, shortened and more colloquially known as The Wealth of Nations. And you might notice that the year 1776 also coincides with the American Revolution because The Wealth of Nations was, in fact, published in the same year as the Declaration of Independence. And like just stop and think about this. The American Revolution was being fought because there should be no taxation without representation. Well, why was this such a huge thing? Like why was it that the British fought this war against France in order to try to hold on to the American colonies, and why was it they were saying, “No, you can only buy sugar from us. No, you can only buy tea from us. No, you can only buy — everything has to have a stamp on it, and we’re going to tax that?” Because Britain was trying to accumulate gold and silver. Like literally the American Revolution was a rebellion in no small part against mercantilism.
[00:13:11] And Adam Smith himself, I mean, he was a Scottish moral philosopher. The term “economist” didn’t exist. Nobody would have said, “Oh, Adam Smith is studying the economy again.” He only wrote two books, The Theory of Moral Sentiments and The Wealth of Nations. And he was a professor. He taught moral philosophy and worked at a tax house. Like he had this nice front seat into seeing things. And it’s interesting because when he was looking at how nations were building wealth, he was looking at it at the twilight of mercantilism because what was happening in England at the time was the early stages of what we now call the Industrial Revolution. Yeah, it had gotten its start a little bit earlier, but it was really taking off and entire towns were being transformed by things like the water frame where the technology was coming in, people were moving off the farms and into factories, people were able to make a wage and then use that money to buy whatever they wanted. Prior to that, under a mercantilist system, each town had to more or less be self-sufficient. And if your town didn’t have a particular resource, chances are good you just didn’t have that thing. The economy and the idea of traveling merchants was actually pretty rare because there wasn’t a whole lot of law outside of the bounds of the village. So if you’re just going down the trail there with a big wagon full of goods, you are a target. And so it’s not exactly a flourishing market economy. But what Adam Smith was looking at was how this whole system was changing, and that’s what he was writing down in The Wealth of Nations.
[00:14:46] And he wasn’t blind at how this was changing the social fabric of his country. People who had lived in towns and had been more or less cloistered for hundreds of years now suddenly were behaving in different ways and in different relations to each other. He was noticing some of what we would eventually start to realize were the downsides to industrialization. And it’s really interesting when you start to consider that Adam Smith was this philosopher because — and I’m going to quote from The Wealth of Nations — he says, quote, no society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. But it is by equity, besides, that they who feed, clothe, and lodge the whole body of the people, should have such a share of the produce of their own labor as to be themselves, tolerably well fed, clothed, and lodged, end quote. What Adam Smith is getting here is to say, under our past systems, we had these feudal lords who controlled all of the means of production. They had the land. They had the money. They had the machines — the machines in this case were like, “Hey, I bought you an ax,” right? They had all this. And so these people really like they didn’t really have any say in the economy. And under mercantilism, we’re bringing in enough gold and enough silver that we’re able to invest, and we’re creating this, what we now call a capitalist economy. But he’s also saying like, no, no. These people who are working in these factories now have choices. They can work in one factory or they can work in another factory, and it is that interplay of their choice that allows this market economy to start to flourish. This is the whole invisible hand concept that he talked about.
[00:16:35] What’s super interesting though is he’s also aware — and this is what this quote is illustrating to — that the barbell distribution of wealth is not healthy. That is to say, a completely lopsided wealth distribution where you have the 1% having the vast majority of the wealth and everyone else is just poor and miserable, that’s not a healthy society. Like that’s not good for anybody. And for a moral philosopher, that’s a problem. And then, on the other side, we have the idea of just like complete equality and just a leveled-off economic system. But Adam Smith would tell you that’s not great either. But he is aware that when it really comes right down to it, I can have a machine, but without someone to work it, it doesn’t matter. Without someone to install it, without someone to build it, without somebody to manage the land and the roads and all that other stuff, none of this matters. Here’s another quote from The Wealth of Nations, quote, labor was the first price, the original purchase-money that was paid for all things. It was not by gold or silver, but by labor, that all of the wealth of the world was originally purchased, end quote. This would feel right at home in the mouth of somebody who is a supporter of Karl Marx, who I don’t think I have to go into the myriad of issues attached to Karl Marx, but this is Adam Smith we’re talking about. This is literally a quote from The Wealth of Nations in which he is talking that labor itself is valuable and that each and every individual within this system has their labor to use to purchase things. And most often, they’re purchasing money. They use their labor; they’re paid a wage. That is the exchange. This was new. We think of this as the like, well, that’s just everything now, but it wasn’t then. And so now, he’s looking at it and going, “Oh my God, like this is different.”
[00:18:30] And he wasn’t the only one. From the period of 1776 to 1848, you basically had a number of individuals who were looking at this arising industrial system and trying to describe it and understand the mechanics of it. Adam Smith was, of course, the first. But you have Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill — John Stuart Mill, of course, being the last one here in 1848. And if that date sounds familiar, that’s also the same year that The Communist Manifesto came out. But I digress, and I’ll get to that hopefully by the end of the episode. All of these people are looking at how wealth was created and distributed, and all of them had more or less the same observations of their particular slice of the world. And it’s notable that a lot of these men were actually English because England, if you remember, was the place where industrialization really grew up. That’s where the first water frames were created. That’s where the first big factory machines and towns were created. England was the spearhead for this. And so it makes a lot of sense that they would then be the people who are actually looking at this and trying to describe it.
[00:19:42] So this brings us to the question: what are the high points then of the classical economic system? So I’m just going to go through several of them and I’m going to try to describe, you know, those high points, who was the like lead philosopher on this type of thing. And, you know, by the end of it, I’m going to discuss some of the criticisms and what the role of government in the view of these classical economists was. And let’s just start with the grandfather of them all: Adam Smith. Adam Smith’s contribution to classical economics basically falls into two categories. The first one is specialization and division of labor. Now, this is something I’ve been saying for years at this point; that when people will say, “Well, kids today don’t even know how to do X, Y, and Z,” my question is, “Why?” Why would they know how to do that? I don’t know how to shoe a horse. Do you? Maybe you do. In fact, now that I think about it, a lot of people I spend time with, probably at least one of them knows how to shoe a horse, but that’s not exactly common knowledge anymore. We don’t have the knowledge of basic carpentry, basic cooking, all sorts of things. Why? Because we’re highly specialized individuals.
[00:20:47] When you go to college and you get a degree, that’s the entire idea. Now, whether or not that works out is entirely separate. But like me specifically, I’m a CPA. Like that’s what I do in my W-2 job. I’m a CPA. I am specialized into that. If I walked in and said, “Hey, I want to be a medical doctor,” they’re going to look at me like I’m crazy because I’m not in that specialization. So what I do is I am exchanging my talents and skills into the economy for money, trusting that somebody else has chosen a different path and a different specialization for the thing that I need, like, you know, going to the doctor.
[00:21:23] The example that Adam Smith used was that of a pin. Now, if you stop and think about it, like a pin is a pretty basic thing, and there are other economists who have used things like a pencil to demonstrate the same concept but on a global scale. But a pin, if I was going to wake up in the morning and go, “I’m going to make a pin today,” the first thing I’d have to do is I’d have to go put on my geologist hat and go find iron ore. Then, I’d have to put on my miner hat and mine the ore. Then, I’d have to put on my smelter hat and smelt the ore into actual iron ingots. Then, I’m gonna have to put on my manufacturing hat to create a forge that’s then going to heat it, and then I’m going to have to pull it, and then I’m going to have to shape it, and then I’m going to have to transport it, then I’m going to have to sell it, and all those things. There is literally no way I could get that done in a day. Like that’s months of work for any individual person. But what Smith had seen was when one person just focuses and specializes, I am really good at finding iron ore, that person becomes a professional geologist. They’re specialized in that thing. They don’t know the first thing about forging a pin. But man, they can find the iron ore. And that’s what you want. Because those people working together, working in their own self-interest because that’s what the market has told them that they should be doing, well, they’re far more efficient, so then more pins are actually produced, which then wealth is spontaneously created, not because we went and strip-mined gold and silver from someplace, but because we created something of value. And that was the major thing that Smith saw. It was the creation of added value. The iron ore by itself was useless. But a pin? A pin has value. And every person in that chain was specialized to help create that value.
[00:23:16] Now, you might have noticed I used another term, which was “self-interest.” Adam Smith had basically said that there is this invisible hand of the market, but I want to just preface that the word “invisible hand” occurs once in the multi-thousand page tome that is The Wealth of Nations. So it’s not like this was a central idea, this idea of the invisible hand, but the idea that the market creates incentives and when people are acting rationally and in their own best interest, the market will function. That’s the self-interest that Smith said. Essentially, if I really just do a good job taking care of myself and you do too, then everything’s going to be fine.
[00:23:52] Now, another high point of the classical economic idea is the idea — something called Say’s Law, which is that supply creates its own demand. And this then suggests that oversupply of anything is impossible. So let’s go back to the pin, for example. What Say’s Law is basically saying is that, well, when should we stop producing pins? And he would say, “Well, no. You should never stop producing pins. Just produce as many as you possibly can because that supply will create its own demand.” If I create so many and I’m having trouble selling them, the price will come down, which then will increase the demand. So Say’s Law is this idea that we can just produce, produce, produce, and we’re never going to produce too much because that production will itself create demand to absorb that production. This is basically rudimentary laws of supply and demand. And so that is the other part and one of the other high points in the classical economic model is this idea of supply and demand. So we have specialization, self-interest, and supply and demand.
[00:24:54] Okay, let’s just keep going. The next part that goes into this classical economic theory is this idea of comparative advantage. This is, of course, you know, where Jean-Baptiste Say had Say’s Law. This is now Ricardo. Ricardo was looking around — now, keep in mind I put these in chronological order. So Smith was first, then Say, now we have Ricardo. Ricardo is about 25 or so years after Smith. And he’s looking around and going, “Well, why is it that this town does this thing and this town over here does this other thing?” And what he comes up with is the idea of comparative advantage. So let’s say that we have two towns in Scotland. One is on the coast and the other one’s in the Highlands. And we noticed that like the one on the coast produces a lot of fish products, right? So they bring in a lot of fish, they salt the fish, and then they’re selling it to the highlands. But the highlands produce like a lot of cheese from their cows, their Scottish Highland cows, and then there’s just tons of wool products that are coming out there. What Ricardo is saying is that those towns have what are called comparative advantage. That is to say that the town in the highlands should never try to produce fish. It makes no sense. They’re not going to be very good at it because of their geographic location. But their geographic location makes them really good at producing cheeses and woolen products and all those other things. And the town that’s down by the coast, they should completely abandon their wool industry and just focus on the fish products because they have a comparative advantage over the town in the highlands. Then, those two will trade and they’ll both be better off. The highlands get fish and the lowlands get wool. And what Ricardo said was that nations should do this, too.
[00:26:28] And we can kind of see this even today because if you ever know the whole like joke of like, well, it’s not really Champagne, unless it comes from the Champagne region of France. Otherwise, it’s just sparkling wine. Well, that’s actually a real thing. Like in international trade law, that’s a real thing. Champagne is a region of France, just like Bordeaux is. And it’s famous for — you guessed it — it’s Champagne. It’s named after the region. And so they focus heavily on that idea. Like, you know, find stinky cheeses and wines. Well, we kind of associate that with France. Well, it’s because they have a comparative advantage in their vineyards and their wine productio. In the same way that we might think of like, oh, well, like all our microchips are made in Taiwan. Well, why? Because Taiwan has a comparable advantage over the rest of the world. And even when I was doing martial arts. When we would do best two out of three and I, you know, you got to pick your style, I would never pick the style I was best at. I would pick the style where I had the biggest difference between their skill level and mine because my comparative advantage would be higher. We do this with jobs. We do this with spouses. We do this with all sorts of things, but Ricardo is the one who wrote it down.
[00:27:38] The next thing that comes with this is the idea of competition because now this is going to dovetail right in here. And I kind of jumped the gun on here because this is really the competition standpoint. Ricardo talked about it, so did Malthus, but John Stuart Mill is really the guy who really started talking about competition. And what John Stuart Mill was saying was he was looking around, and he’s walking to the market and he sees one, two, three, four butcher shops. And what he’s saying is is that each one of those butchers is incentivized by the market through competition to keep their prices low and their product quality high because if they don’t, then everyone in the market will just go to their competition. That is to say that without that competition, the market’s not functioning. He was very much against monopolies. And so his idea was that, well, no, really what we need is as many butchers as humanly possible. We want as much competition, as many people into the market, and that’s what’s going to create the self-regulation of the market. So you’ve heard people be like, “Markets regulate themselves.” Yeah, they got that idea from John Stuart Mill who said, “Yeah, that’s true if and only if we have tons of vibrant competition.” So if you think about like the landscape today, when you realize that there’s like, what, four companies that control all the food in the United States, not exactly vibrant competition. So like if we look back to the 1950s and ’60s, which would be our parents’ generations and one of the periods of greatest economic expansions in human history, there were just hundreds of companies all competing. And that, ladies and gentlemen, is one of the major contributing factors as to why we had such economic boom during that period of time. Competition is what regulates the market. Competition is what improves the lives of consumers. Competition is healthy. That’s John Stuart Mill.
[00:29:28] John Stuart Mill, though, you might notice comparative and I said I alluded to this earlier — is that he published his book, and he’s published a lot, but like he’s also known for his own moral philosophy. Most of these men were. But John Stuart Mill was at a time in which The Communist Manifesto came out. And if you’ve ever read The Communist Manifesto, Das Kapital and Communist Manifesto thoroughly on the books that Dylan has read so you don’t have to. They’re really hard to read, but I digress. The point that I’m getting to here is that they were basically looking around and going, “Hm. Some of this has gone wrong.” That is to say, what they were seeing were orphans, child labor, massive amounts of pollution, destitution for people who have been injured in the machines. And so John Stuart Mill also started to talk about wages and profits being inverse. That is to say that in his mind, what you would have is the higher wages were, the lower the profits of the company would be. And the higher the profits of the company, well, that was caused by the lower wages. So what he noticed was that there’s always going to be this tension between the profits of the company and the wages of the employees. And what he noticed was is that different companies in a town would collude in order to drive wages as low as they possibly could so that their profits could be as high as they possibly could.
[00:30:50] This is pretty much where people start going, “Wait, hold on a second. You start sounding like a commie Dylan.” No, I’m not a commie. I’m just the guy who read the entire book, okay? And this is part of it too because he wasn’t the first person to look at this and go, “Oh my God, there’s a problem here.” Because remember I said Thomas Malthus was in here, too. And if you know Thomas Malthus, he was the guy who said that we’re going to eventually run out of our ability to create food, and then we’re all going to starve and there’s going to be just everything’s going to be sad. The entire term “the dismal science” really was coined — and I shit you not — was coined by a guy who read Malthus’ work and went, “God, that’s just terrible.” Like that’s where the entire thing got coined. But what Malthus missed was the rise of technology being able to create increased production. But what he didn’t miss was the link between population and labor supply. Now, go all the way back to The Wealth of Nations. And what did Adam Smith say? Quote, Labor was the first price, the original purchase-money that was paid for all things. It was not by gold or silver, but by labor, that all the wealth of the world was originally purchased, end quote. What Malthus was seeing was that as the wages were higher, populations would increase. Eventually, we’d run out of food, and that would then cause the population to decrease, which would then cause wages to increase, and there’s going to be this constant cycle.
[00:32:17] And so a lot of Malthus’ work was like, how do we manage the boom and bust cycles of populations that’s being driven by industrialization? He was wrong on that, but his insight was good. Because Ricardo, the guy who came up with comparative advantage, he had something called the Iron Law of Wages. And what he had said was that essentially in the beginning when industries are growing, they’re just trying to get as many people in from the farms as humanly possible, so they offer a large wage. Those people then have means, they buy homes or they rent apartments, they get wives, they have kids, they’re able to feed more, population increases, therefore the supply of labor increases, and what that ends up doing is then depressing wages. So in his mind, in Ricardo’s mind, the end state of this capitalistic system was poverty and destitution for workers because the Iron Law of Wages would trend to trying to pay them nothing over time.
[00:33:12] And so like he wasn’t the only one. Mill was not the only one to notice this linkage between population, wages, and profits of companies, and then the various incentives within classical economics for people who ran the factories to actually try to depress those wages. And all of them were aware of this. Even Adam Smith was concerned about the distribution of wealth. It was the wealth of nations, not the wealth of nobility. And so they all kind of talked about like what would be — what’s the solution? And, of course, the solution was always what is the role of government. And for the most part, these thinkers said that the role of government was very minimal. In Smith’s case, he said that government was really just basically supposed to provide defense, public order, and infrastructure, and that the vibrant market would take care of the rest. But again, what he missed was the competition piece and the tendency for the markets to start to monopolize. Say himself said that stable institutions was the role of government. So it didn’t really matter what they were doing, just so long as there was stability and certainty.
[00:34:15] And Jordan B. Peterson has talked about this in his second book — well, it’s his third book, really — but it’s Beyond Order: 12 More Rules for Life. He talks about in that book, you know, not just undermining institutions because you don’t like them. And just to stop for a second and think like what is this providing into the stability of society. Maybe it’s worth it for that. And if I want to change it, maybe something more subtle or slow is the way to go. Now, again, there’s some people who will say, “Well, that seems like a Communist idea.” Well, if you’re going to go call Jordan B. Peterson a Communist, by all means, go. You give it a shot. Let me know how it goes. But we’re also talking about Adam Smith here. We’re also talking about Ricardo. We’re also talking about John Stuart Mill.
[00:34:58] Say himself also said that the role of government was to enforce contracts. And in his mind, if we can negotiate a contract, well, then, you know, all the government needs to do is enforce that contract and it’d be fine. But it was John Stuart Mill who then came in and pointed out rightfully that the ability to negotiate a contract is dependent on both parties having equal or close to equal power in that negotiation. And what John Stuart Mill was seeing — now, remember he’s the last of these guys. He’s the very end where we’ve had plenty of time for this system to develop. And what he’s looking around and saying, “Well, but these textile mills in these Scottish towns have now coalesced where there’s just one in each town,” meaning that it has a monopsony power. That is, the sole buyer of something; in this case, the labor of the people. And so they get to set the price now. What John Stuart Mill would say is that’s called a market failure. The market failed to provide the goods and services that was promised because it’s distorted. It’s out of whack. And so that monopsony power that that factory has is bad. It’s wrong. It’s a market failure, and the government should step in and break it up. That’s what he was talking about.
[00:36:12] Examples of market failures that we have here in the United States is that we have one of the least regulated healthcare systems in the world. And I know that’s a controversial statement, and it’s also true. We don’t have any single-payer health insurance other than Medicare. But the idea is that like, well, we’re going to have this competition and this vibrant market, as hospitals consolidate and insurance companies consolidate into greater and greater pillars of this system, whose power cannot be checked. And so the idea was, well, you know, it’ll provide a superior product at a lower price. Well, it doesn’t. Anyone who’s had to go to the hospital in the United States knows this. The United States medical system is one gigantic market failure by design. And John Stuart Mill would say the government’s role is to come in and stop that because you, the consumer, are worse off because of that market failure.
[00:37:03] The other thing that John Stuart Mill said was that there should be some sort of protection for workers and social welfare for orphans if your dad and your mom die working in the factories. Well, you shouldn’t just be out on the street. If a worker loses his arm because he’s working in a mine and there’s a collapse, there should be some sort of system to help that person continue with dignity. And that was his big thing — to continue with dignity. The other thing that Mill said at this point is — and Mill was some would call him a proto-feminist because he also looked at the labor supply and said, “Hey” — and this is England in, you know, the mid-1800s. He also said, “Well, there’s all these laws saying women can or cannot work in these different professions.” And the argument in his day was, well, women aren’t capable of it, so we need to ban them. Well, he pointed out two things. Number one: it makes no sense to ban women from doing a job because if they physically can’t do it, well, then, you don’t need a law. It’s just not physically possible. You don’t tell men, “Hey, you can’t fly here” because it’s not possible for us to fly. The other thing he noticed was that you’re leaving 50% of the labor force on the sidelines. So if you wanted to have more production, employ more women. And so he was pioneering that at the exact same time that he’s looking at the system that he’s in and identifying market failures.
[00:38:28] So I’m going to leave you with some criticisms of the classical economic model. I think the very first one, and I think it’s a very fair criticism, is that it oversimplifies human behavior. Classical economics turns on the entire idea that at the end of the day, every single person in an economy is perfectly rational and has perfect information as compared to everyone else in terms of the economic ups and downs of various choices. That’s complete bullshit. Entire industries in the United States currently operate on information asymmetry. In fact, it is in their best interest to make as much confusion as humanly possible. The U. S. tax code is example one of this, okay? When you look at the classical economic theories, the people who would criticize it would say like, “No, like you’re assuming that human beings have no emotions.” And if you’re listening to me, you know that my big thing is money’s emotional. Not all things are equal. People make decisions based upon their emotions and their gut instincts far more than what they’re, you know, they’re thinking gray matter tells them they’re supposed to do. If nothing else, ask yourself, well, if a better job appeared in a complete different part of the country, could you be there by the end of next week? And you’d be like, well, of course not. I gotta get the kids out of school and there’s my family to consider. I’d have to quit my current job. I’m going to sell my house and pack everything up and move. That’s just proof that there’s actually barriers to you just making the rational economic choice because, you know, rational economic choice would be, no, just go to the job. But you wouldn’t because there’s other things. This is the oversimplification people are talking about.
[00:40:01] The second criticism is that it ignores its own thesis on wages and social welfare. And this is really where like I’ve come in and I started off the show by saying it’s always fascinating to me that people don’t read the whole book. Like people cherry-pick the word “invisible hand” out of The Wealth of Nations. It’s in there one time. The Wealth of Nations sits on the bookshelf directly behind me as I’m recording this. I have read it cover to cover, not once but twice. I checked. It’s in there once. But people cherry-picked that and completely ignored his entire commentary on the vibrant political community that has to come up around these economic systems. And that vibrant political community, if the market is working correctly, should have no one in poverty, no one homeless. That’s how you know if the system is working. So Adam Smith would be somebody to say, “Every homeless person is a failure of capitalism.” That would be his standpoint, and it would be the same standpoint for, Say, Ricardo, Mill, and Malthus. And yet people forget that. So when people are looking at like these markets and saying like, “Oh, like the market can self-regulate,” they completely forget what Mill said about competition. They completely forget that Adam Smith’s entire concern was how do we fairly and equitably distribute the wealth that’s created by the nations.
[00:41:22] Which brings us to the last part, which is unrealistic models and assumptions. A lot of these models are philosophy. And economics, at the end of the day, is a field of philosoph. Because it’s really hard to test anything these people come up with. And so like, Say himself, when Jean-Baptiste Say was looking at competition, one of the things he said was, “Under perfect competition, blah, blah, blah, blah.” Ladies and gentlemen, is there ever a perfect competition? Wouldn’t perfect competition just be a stalemate? Yeah, you kind of see the problem here, right? Even John Stuart Mill was looking at it and saying, “Well, a perfectly competitive market and that should be the goal — to be as competitive as humanly possible.” Well, there’s some downsides to that, particularly when you get into things like telecoms and power utilities and water and all that other stuff that he didn’t actually have to go look at. The models weren’t realistic. That doesn’t mean they were wrong.
[00:42:16] At the end of the day, classical economics was our first attempt to really start to solve the economic question: how do we allocate scarce resources in the face of unlimited human desires? And I think when you study classical economics, it’s so easy for us to go, “Aha! This one place they’re wrong. Throw it all out. None of this is valid.” And that wouldn’t be fair because the economic problem is eternal. It exists whether we like it or not, and it’s always been with us. How do we allocate scarce resources in the face of infinite human desires? And that question doesn’t have an answer, and none of the schools of economic thought that I’m going to cover on this series will answer that question. They just try to be close enough to give us some idea of what we can and cannot do or should or should not do given a certain set of circumstances. No answer is going to completely encapsulate the economy, which is a byproduct of human nature, which is itself beautiful, mysterious, and so often, completely irrational.
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